You are considering opening a premium lemonade stand on the corner of Main and Anywhere Street in your hometown.

You have determined that you will need $1,025 to buy equipment, a table, two chairs and other sundry items to get started. Youll also need $250 in the bank to make change with customers and purchase lemonade drink mix in a variety of flavours, including traditional lemonade, strawberry, cherry and grape flavours. Each cup of lemonade that you sell will be priced at $9.99 (after all this lemonade is made from your grandmothers secret recipe).

Sales in year 1 are estimated to be 100 cups, and you predict that sales will rise by 20% annually between in years 2 and 5. Direct materials costs are estimated to be 50% of annual sales and direct labour costs 20% of annual sales.

Fixed preparation costs will be $250 annually.

You are financing the business with a single $500 par value bond issued to your parents at a price of 135. The bond has a 10% coupon rate, and a term of 5 years. You have also issued 600 common shares to other family members at a price of $1 per share.

You recently read in the Times of Anywhere (a local newspaper) that risk free investments are offering an 8% return, and that the beta on lemonade stands is .80. The expected return in the premium lemonade market is 10%.

You have also confirmed with your accounting professor that the companys tax rate will be 10%, and the depreciation rate on lemonade stands is 15%.

Finally, your research has also determined that lemonade stands are predicted to have a perpetual growth rate of 2% after the first five years of operation.

G

True/False: The split between debt/equity (bonds/common shares) is approximately 75%/25%.

1. True
2. False

H

True/False: Typically, the risk free rate is the yield-to-maturity on the Government of Canada ten-year bond.

1. True
2. False

i.

In class we learned how to calculate the annual depreciation tax shield on large capital investment projects. In the case of your lemonade stand, the total tax allowable depreciation is $_______.

1. $1,025
2. $750
3. $275
4. $154